Description

BCE Inc., old Bell Canada, is a very boring company. Old land lines, new 3G wireless technology, and some HDTV won't make anyone salivate. But with very stable revenues, aggressive cost cutting, and a looming end to increasing capital expenditures, it does look like a "bond alternative". On the most recent conference call, addressing Q3, the CEO, Geo. Cope, as much as admitted that the company is managed to sustain, and increase the common stock dividend. ("....it is very clear to the investment community that our strategy of a dividend growth model is exactly how we plan to focus execution at the organization.") The current dividend yield is crudely 6%, and should increase by about 5% pa. The "wrinkle/ reward" here is that the company is Canadian( as you might have surmised), and therefore earns its money in Canadian dollars [CAD]. If you believe, as I do, that the US dollar [USD] will suffer inevitable and persistent decline, then the risk of having a CAD asset (and dividend payer) is a "wrinkle" and not a "risk". Of course, if we have another financial panic, a flight to USDs, however temporary, is likely. Everything suggests that the CAD will appreciate: the economy is much stronger than the US economy, is much more reliant on commodity prices, actually has a solvent and functioning bank system, and does not have a socialist government. If you are concerned about the FX risk, hedge it (but, imho, it is the cake on the icing to this story). For those of you who are newly-rich, or nearly- dead (mutually exclusive classes in this economy) and thus impatient for a précis, here it is: (data, and data errors, courtesy of Bloomberg)

Return on assets 2.1%

Return on common equity 5.7%

Return on capital 6.1%

Dividend estimated yield 5.8%

EV to trailing EBITDA 4.7x

Price to free cash flow 7.8x

Best est l/t growth 11.6%

Net sales - 5yr geo growth -1.1%

EBIT to total interest exp 4.7x

Total debt to EBITDA 1.8x

CFO to total debt 0.5x

Trailing 12M operating margin 21.7%

Trailing 12M profit margin 7.6%

Price to sales 1.2x

Estimated P/E current year 11.0x

Estimated P/E next year 11.0x

PEG ratio 1.0x

Current market cap C$21,074

Preferred equity C$2,770

Minority interest C$1,080

Total debt C$12,300

Cash and near cash C$3,059

Current EV C$34,786

The CAD trades at about 94 cents US.

By way of comparison, the 10 year United States Treasury bond yields 3.3% (fixed, not accreting), is "supported" by reported debt to GDP of soon-to-be 100%, or all-in (off-balance-sheet debt included) of some 500%. Almost certainly, the UST will find a way to return dollars to you that have less purchasing power than those lent to it. (I hope that this will not engender a political debate, as those are difficult to sustain in the US without ad hominum attacks - and it's demeaning to attack someone with a name like "niblick365".)

With the likely dividend raise forecast for feb2010, and using the high end of the eps guidance just given (C$2.40-C$2.50; the whisper numbers are already higher), the payout ratio for 2010 will be 67%. The dividend coverage (CFFO- capex/common and preferred dividends) ratios are 2.6x (both for Q3 and LTM). The largest part of the capital expenditure plan has been executed, the Company will continue to buy back stock, and the cost cutting will continue -- all factors which will keep the dividend coverage comfortably high.

BCE is the incumbent phone provider to more than 7 million subs in Ontario and Quebec; it provides internet broadband, and digital video to about 2 million subscribers. Additionally, its 44% owned group Bell Aliant, reaches an additional 3 million local customers, and 700,000 broadband customers in the Atlantic provinces. BCE wireless services reach about 6.5 million subs. Recently, BCE bought "The Source" electronics store from bankrupt Circuit City, which gives it 750 stores and a prominent "street level" presence.

In 2007, BCE capitulated to a bear-hug "friendly" LBO. Led by the Ontario Teachers, Providence Equity partners, and Madison Dearborn it would have been the largest LBO ever done. With financing all but impossible, the deal was terminated when the purchasers could not close on 12/11/08. In retrospect, the Company benefitted from the scrutiny and discipline engendered by the buyout - but the shareholders lost the opportunity to cash out at C$42.75. Ouch. Now merely a financial footnote, the deal has left an anomaly in the middle of comparable financial statements; and an ongoing resolution to pare corporate expenses - particularly management overhead. (Management headcount was down 15% in '08'09.)

The broad themes of telephony here "south of the border "are playing-out in Canada as well. Traditionally high revenue land lines are succumbing to wireless technology; the legacy carriers are in a "newspaper" industry. They must develop a rival capacity to their landlines, and landline revenues are declining and regulated. Their only choice has been to cut costs faster than revenues are declining. BCE is doing that, and has said they will continue to do it. Wireline margins have been essentially unchanged for 5 years.

In wireless offerings, the company has already built-out a 3G capability (HSPA), and although ARPU is down 6.4% yoy (a/o Q3), market share is up 6.7% yoy. The economy is the culprit in ARPU, so when the recovery manifests, revenues should mend. Wireless penetration in Canada is only 67% (vs 90% in the USA). At the current rate of growth, it would take 6 years to reach the comparable USA level. Postpaid subscribers grew 7.7% yoy (Q3), vs 2.6% for the USA. Clearly new competition will emerge in Canada, but the inherent advantages of the current three oligopoly players are considerable.

In 2009q3, revenues were up 1.2%, wireless ARPU declined, EBITDA was up 1.8%, total wireless adds were up 15.4%, BellTV ARPU was up 6.4% yoy, capex came-in at 15.5% of revenues, and a new roaming agreement was signed with AT&T. EPS were C$0.84 vs estimates in the C$0.64 neighborhood. Unfortunately/ fortunately, this has led to a cascade of buy-ratings for the stock.

Q3 Q2 Q1 Q4 Q3 Q2 Q1 Q4

Rev 4.46 4.30 4.33 4.48 4.44 4.39 4.36 4.50

EBITDA 1.80 1.80 1.76 1.74 1.77 1.74 1.75 1.68

% EBITDA 40% 42% 41% 39% 40% 40% 40% 40%

EBIT .78 .82 .83 .67 .67 .89 .65 .75

%EBIT 17% 19% 19% 15% 15% 20% 15% 17%

Net Income .58 .37 .41 (.02) .28 .39 .29 2.39

Shares Out 767 769 788 806 806 806 805 805

EPS $.72 $.45 $.49 (.01) $.34 $.48 $.32 $2.96

YTD 2009 YTD 2008 %CHG

Wireline rev 7.83 7.91 -1.1%

Wireless rev 3.36 3.35 0.4%

Bell rev 11.04 11.07 -0.3%

Total rev 13.09 13.29 -0.8%

Wireless income .99 .95 4.8%

Bell income 1.86 1.62 14.6%

Total income 2.44 2.20 10.8%

%income 19% 17%

LTM Q3

LTM Q2

LTM Q1

LTM Q4

LTM Q3

LTM Q2

LTM Q1

LTM Q4

Revenue% chg

3.6%

-0.9%

-3.3%

1.1%

1.0%

0.8%

-3.5%

0.9%

Product/Brand Segments

Bell Wireline

44.5%

44.4%

44.1%

44.0%

59.1%

59.1%

58.8%

58.7%

Data (Internet Service)

15.4%

15.6%

15.4%

15.5%

20.9%

20.7%

20.6%

20.4%

Local and Access

13.6%

13.9%

14.1%

14.3%

19.2%

19.5%

19.3%

19.6%

Video

6.7%

6.5%

6.3%

6.1%

8.1%

7.8%

7.6%

7.4%

Long Distance

4.6%

4.8%

4.9%

5.0%

6.7%

6.8%

6.8%

6.8%

Equipment and Other

2.8%

2.3%

2.5%

2.7%

3.7%

3.8%

4.0%

4.0%

Bell Wireless

19.1%

19.1%

19.1%

18.8%

24.9%

24.3%

23.6%

23.1%

Wireless Network

17.3%

17.4%

17.3%

17.1%

22.6%

22.0%

21.5%

21.1%

Equipment and other

1.6%

1.6%

1.7%

1.6%

2.3%

2.1%

2.0%

1.9%

Bell Alliant

13.7%

13.9%

13.7%

13.3%

18.1%

18.1%

18.0%

17.9%

Local and Access

5.8%

5.8%

5.9%

5.9%

5.9%

5.9%

6.0%

6.0%

Data

2.7%

2.6%

2.5%

2.5%

2.5%

2.4%

2.2%

2.2%

Long Distance

1.7%

1.8%

1.8%

1.8%

1.8%

1.9%

1.9%

1.9%

Equipment and Other

1.9%

2.1%

2.3%

2.3%

2.3%

2.3%

2.2%

2.2%

Wireless

0.3%

0.3%

0.3%

0.3%

0.3%

0.3%

0.2%

0.2%

Telesat

0.0%

0.0%

0.0%

0.0%

0.3%

1.0%

1.9%

2.6%

Geographic Segments

100.0%

100.0%

100.0%

100.0%

100.0%

100.0%

100.0%

100.0%

Operating Income

21.7%

21.8%

21.6%

21.5%

21.6%

21.6%

21.6%

21.7%

Bell Wireless

5.6%

5.6%

5.4%

5.4%

7.0%

6.9%

6.8%

6.8%

Bell Wireline

4.9%

4.3%

4.7%

3.7%

5.1%

6.5%

6.6%

7.9%

Bell Alliant

3.3%

3.3%

3.3%

2.3%

3.3%

3.1%

3.0%

4.0%

Telesat

0.0%

0.0%

0.0%

0.0%

0.1%

0.3%

0.7%

0.9%

- Interest Expense

4.3%

4.4%

4.4%

4.5%

4.5%

4.6%

4.7%

4.8%

Pretax Income

11.7%

11.1%

11.5%

10.5%

25.3%

26.4%

26.2%

28.2%

- Income Tax Expense

1.8%

2.7%

2.9%

2.7%

4.2%

4.6%

3.5%

4.1%

Income Before XO Items

9.9%

8.4%

8.6%

7.9%

21.1%

21.8%

22.6%

24.0%

- Minority Interests

1.8%

1.8%

1.9%

1.8%

1.8%

1.8%

1.7%

1.9%

Net Income

7.6%

5.9%

6.0%

5.3%

18.9%

19.8%

21.5%

22.8%

Basic EPS

$ 1.63

$ 1.22

$ 1.22

$ 1.06

$ 4.01

$ 4.20

$ 4.58

$ 4.88

Dividends per Share

$ 1.54

$ 1.14

$ 0.75

$ 0.73

$ 0.73

$ 1.10

$ 1.46

$ 1.46

2009

2010

2011

Bell Canada Rev

15,000

15,500

16,000

Total Rev

17,800

18,250

18,750

Bell Canada EBITDA

5,800

5,850

6,000

%EBITDA

39%

38%

38%

Total EBITDA

7,100

7,200

7,400

%ebitda

40%

39%

39%

Capex

2,670

2,646

2,531

FCF

4,430

4,554

4,869

All numbers in CAD.

Looking forward, valuation and risk are the key questions. Using 5x 2010 EBITDA for wireline, 6.25x 2010 EBITDA for wireless, market price for Bell Aliant, and C$1300 per sub for Bell Video, yields a c$33 price target (using TD Newhouse estimates). Other valuations are quite similar, and those with lower EBITDA and EPS are using higher multiples to achieve target prices of C$30-C$31. To me, given my thesis of a high-yield equity, the question of a "bad" case scenario is more relevant: 9x base-case" eps of C$2.55, and a yield of 7.25% would support the stock at C$23. A PER of 10x,and a yield of 6.4% would suggest net exposure of around 10% -- not unattractive given a 6% yield..

The greatest risk is a "double-dip" recession, where churn and ARPU conspire together, and even then I suggest that the exposure is small.

Catalyst

Description

BCE Inc., old Bell Canada, is a very boring company. Old land lines, new 3G wireless technology, and some HDTV won't make anyone salivate. But with very stable revenues, aggressive cost cutting, and a looming end to increasing capital expenditures, it does look like a "bond alternative". On the most recent conference call, addressing Q3, the CEO, Geo. Cope, as much as admitted that the company is managed to sustain, and increase the common stock dividend. ("....it is very clear to the investment community that our strategy of a dividend growth model is exactly how we plan to focus execution at the organization.") The current dividend yield is crudely 6%, and should increase by about 5% pa. The "wrinkle/ reward" here is that the company is Canadian( as you might have surmised), and therefore earns its money in Canadian dollars [CAD]. If you believe, as I do, that the US dollar [USD] will suffer inevitable and persistent decline, then the risk of having a CAD asset (and dividend payer) is a "wrinkle" and not a "risk". Of course, if we have another financial panic, a flight to USDs, however temporary, is likely. Everything suggests that the CAD will appreciate: the economy is much stronger than the US economy, is much more reliant on commodity prices, actually has a solvent and functioning bank system, and does not have a socialist government. If you are concerned about the FX risk, hedge it (but, imho, it is the cake on the icing to this story). For those of you who are newly-rich, or nearly- dead (mutually exclusive classes in this economy) and thus impatient for a précis, here it is: (data, and data errors, courtesy of Bloomberg)

Return on assets 2.1%

Return on common equity 5.7%

Return on capital 6.1%

Dividend estimated yield 5.8%

EV to trailing EBITDA 4.7x

Price to free cash flow 7.8x

Best est l/t growth 11.6%

Net sales - 5yr geo growth -1.1%

EBIT to total interest exp 4.7x

Total debt to EBITDA 1.8x

CFO to total debt 0.5x

Trailing 12M operating margin 21.7%

Trailing 12M profit margin 7.6%

Price to sales 1.2x

Estimated P/E current year 11.0x

Estimated P/E next year 11.0x

PEG ratio 1.0x

Current market cap C$21,074

Preferred equity C$2,770

Minority interest C$1,080

Total debt C$12,300

Cash and near cash C$3,059

Current EV C$34,786

The CAD trades at about 94 cents US.

By way of comparison, the 10 year United States Treasury bond yields 3.3% (fixed, not accreting), is "supported" by reported debt to GDP of soon-to-be 100%, or all-in (off-balance-sheet debt included) of some 500%. Almost certainly, the UST will find a way to return dollars to you that have less purchasing power than those lent to it. (I hope that this will not engender a political debate, as those are difficult to sustain in the US without ad hominum attacks - and it's demeaning to attack someone with a name like "niblick365".)

With the likely dividend raise forecast for feb2010, and using the high end of the eps guidance just given (C$2.40-C$2.50; the whisper numbers are already higher), the payout ratio for 2010 will be 67%. The dividend coverage (CFFO- capex/common and preferred dividends) ratios are 2.6x (both for Q3 and LTM). The largest part of the capital expenditure plan has been executed, the Company will continue to buy back stock, and the cost cutting will continue -- all factors which will keep the dividend coverage comfortably high.

BCE is the incumbent phone provider to more than 7 million subs in Ontario and Quebec; it provides internet broadband, and digital video to about 2 million subscribers. Additionally, its 44% owned group Bell Aliant, reaches an additional 3 million local customers, and 700,000 broadband customers in the Atlantic provinces. BCE wireless services reach about 6.5 million subs. Recently, BCE bought "The Source" electronics store from bankrupt Circuit City, which gives it 750 stores and a prominent "street level" presence.

In 2007, BCE capitulated to a bear-hug "friendly" LBO. Led by the Ontario Teachers, Providence Equity partners, and Madison Dearborn it would have been the largest LBO ever done. With financing all but impossible, the deal was terminated when the purchasers could not close on 12/11/08. In retrospect, the Company benefitted from the scrutiny and discipline engendered by the buyout - but the shareholders lost the opportunity to cash out at C$42.75. Ouch. Now merely a financial footnote, the deal has left an anomaly in the middle of comparable financial statements; and an ongoing resolution to pare corporate expenses - particularly management overhead. (Management headcount was down 15% in '08'09.)

The broad themes of telephony here "south of the border "are playing-out in Canada as well. Traditionally high revenue land lines are succumbing to wireless technology; the legacy carriers are in a "newspaper" industry. They must develop a rival capacity to their landlines, and landline revenues are declining and regulated. Their only choice has been to cut costs faster than revenues are declining. BCE is doing that, and has said they will continue to do it. Wireline margins have been essentially unchanged for 5 years.

In wireless offerings, the company has already built-out a 3G capability (HSPA), and although ARPU is down 6.4% yoy (a/o Q3), market share is up 6.7% yoy. The economy is the culprit in ARPU, so when the recovery manifests, revenues should mend. Wireless penetration in Canada is only 67% (vs 90% in the USA). At the current rate of growth, it would take 6 years to reach the comparable USA level. Postpaid subscribers grew 7.7% yoy (Q3), vs 2.6% for the USA. Clearly new competition will emerge in Canada, but the inherent advantages of the current three oligopoly players are considerable.

In 2009q3, revenues were up 1.2%, wireless ARPU declined, EBITDA was up 1.8%, total wireless adds were up 15.4%, BellTV ARPU was up 6.4% yoy, capex came-in at 15.5% of revenues, and a new roaming agreement was signed with AT&T. EPS were C$0.84 vs estimates in the C$0.64 neighborhood. Unfortunately/ fortunately, this has led to a cascade of buy-ratings for the stock.

Q3 Q2 Q1 Q4 Q3 Q2 Q1 Q4

Rev 4.46 4.30 4.33 4.48 4.44 4.39 4.36 4.50

EBITDA 1.80 1.80 1.76 1.74 1.77 1.74 1.75 1.68

% EBITDA 40% 42% 41% 39% 40% 40% 40% 40%

EBIT .78 .82 .83 .67 .67 .89 .65 .75

%EBIT 17% 19% 19% 15% 15% 20% 15% 17%

Net Income .58 .37 .41 (.02) .28 .39 .29 2.39

Shares Out 767 769 788 806 806 806 805 805

EPS $.72 $.45 $.49 (.01) $.34 $.48 $.32 $2.96

YTD 2009 YTD 2008 %CHG

Wireline rev 7.83 7.91 -1.1%

Wireless rev 3.36 3.35 0.4%

Bell rev 11.04 11.07 -0.3%

Total rev 13.09 13.29 -0.8%

Wireless income .99 .95 4.8%

Bell income 1.86 1.62 14.6%

Total income 2.44 2.20 10.8%

%income 19% 17%

LTM Q3

LTM Q2

LTM Q1

LTM Q4

LTM Q3

LTM Q2

LTM Q1

LTM Q4

Revenue% chg

3.6%

-0.9%

-3.3%

1.1%

1.0%

0.8%

-3.5%

0.9%

Product/Brand Segments

Bell Wireline

44.5%

44.4%

44.1%

44.0%

59.1%

59.1%

58.8%

58.7%

Data (Internet Service)

15.4%

15.6%

15.4%

15.5%

20.9%

20.7%

20.6%

20.4%

Local and Access

13.6%

13.9%

14.1%

14.3%

19.2%

19.5%

19.3%

19.6%

Video

6.7%

6.5%

6.3%

6.1%

8.1%

7.8%

7.6%

7.4%

Long Distance

4.6%

4.8%

4.9%

5.0%

6.7%

6.8%

6.8%

6.8%

Equipment and Other

2.8%

2.3%

2.5%

2.7%

3.7%

3.8%

4.0%

4.0%

Bell Wireless

19.1%

19.1%

19.1%

18.8%

24.9%

24.3%

23.6%

23.1%

Wireless Network

17.3%

17.4%

17.3%

17.1%

22.6%

22.0%

21.5%

21.1%

Equipment and other

1.6%

1.6%

1.7%

1.6%

2.3%

2.1%

2.0%

1.9%

Bell Alliant

13.7%

13.9%

13.7%

13.3%

18.1%

18.1%

18.0%

17.9%

Local and Access

5.8%

5.8%

5.9%

5.9%

5.9%

5.9%

6.0%

6.0%

Data

2.7%

2.6%

2.5%

2.5%

2.5%

2.4%

2.2%

2.2%

Long Distance

1.7%

1.8%

1.8%

1.8%

1.8%

1.9%

1.9%

1.9%

Equipment and Other

1.9%

2.1%

2.3%

2.3%

2.3%

2.3%

2.2%

2.2%

Wireless

0.3%

0.3%

0.3%

0.3%

0.3%

0.3%

0.2%

0.2%

Telesat

0.0%

0.0%

0.0%

0.0%

0.3%

1.0%

1.9%

2.6%

Geographic Segments

100.0%

100.0%

100.0%

100.0%

100.0%

100.0%

100.0%

100.0%

Operating Income

21.7%

21.8%

21.6%

21.5%

21.6%

21.6%

21.6%

21.7%

Bell Wireless

5.6%

5.6%

5.4%

5.4%

7.0%

6.9%

6.8%

6.8%

Bell Wireline

4.9%

4.3%

4.7%

3.7%

5.1%

6.5%

6.6%

7.9%

Bell Alliant

3.3%

3.3%

3.3%

2.3%

3.3%

3.1%

3.0%

4.0%

Telesat

0.0%

0.0%

0.0%

0.0%

0.1%

0.3%

0.7%

0.9%

- Interest Expense

4.3%

4.4%

4.4%

4.5%

4.5%

4.6%

4.7%

4.8%

Pretax Income

11.7%

11.1%

11.5%

10.5%

25.3%

26.4%

26.2%

28.2%

- Income Tax Expense

1.8%

2.7%

2.9%

2.7%

4.2%

4.6%

3.5%

4.1%

Income Before XO Items

9.9%

8.4%

8.6%

7.9%

21.1%

21.8%

22.6%

24.0%

- Minority Interests

1.8%

1.8%

1.9%

1.8%

1.8%

1.8%

1.7%

1.9%

Net Income

7.6%

5.9%

6.0%

5.3%

18.9%

19.8%

21.5%

22.8%

Basic EPS

$ 1.63

$ 1.22

$ 1.22

$ 1.06

$ 4.01

$ 4.20

$ 4.58

$ 4.88

Dividends per Share

$ 1.54

$ 1.14

$ 0.75

$ 0.73

$ 0.73

$ 1.10

$ 1.46

$ 1.46

2009

2010

2011

Bell Canada Rev

15,000

15,500

16,000

Total Rev

17,800

18,250

18,750

Bell Canada EBITDA

5,800

5,850

6,000

%EBITDA

39%

38%

38%

Total EBITDA

7,100

7,200

7,400

%ebitda

40%

39%

39%

Capex

2,670

2,646

2,531

FCF

4,430

4,554

4,869

All numbers in CAD.

Looking forward, valuation and risk are the key questions. Using 5x 2010 EBITDA for wireline, 6.25x 2010 EBITDA for wireless, market price for Bell Aliant, and C$1300 per sub for Bell Video, yields a c$33 price target (using TD Newhouse estimates). Other valuations are quite similar, and those with lower EBITDA and EPS are using higher multiples to achieve target prices of C$30-C$31. To me, given my thesis of a high-yield equity, the question of a "bad" case scenario is more relevant: 9x base-case" eps of C$2.55, and a yield of 7.25% would support the stock at C$23. A PER of 10x,and a yield of 6.4% would suggest net exposure of around 10% -- not unattractive given a 6% yield..

The greatest risk is a "double-dip" recession, where churn and ARPU conspire together, and even then I suggest that the exposure is small.